As the United States faces the looming threat of recession, much attention has been given to its ballooning bilateral trade deficit with China. As with Japan during its "economic miracle," the demands of political economy have driven many U.S. policymakers to view the trade imbalance solely in terms of benefits to the dominant exporter. And as with Japan, many in Washington, small U.S. manufacturing firms, and trade unions have alleged that this imbalance is due to unfair foreign competition afforded by manipulative currency under valuation.

Even supposing an artificially weak yuan, it would be unwise to place the blame for the decline of U.S. export industries solely on exchange rates. Although an undervalued yuan may produce painful short-term adjustments in the U.S. economy, the long-term impact of a weak yuan is not the end of U.S. global competitiveness. Rather, the U.S. trade deficit is the natural consequence of larger macroeconomic forces within the U.S. economy.

Thinking Beyond Bilateral Trade:

The U.S.-Chinese trade imbalance is more than an issue of bilateral trade. As opposed to more developed economies, such as that of Japan, the Chinese economy is not vertically integrated to the point that products are manufactured from start to finish in China. Further, most products manufactured within China are manufactured by foreign firms; according to Chinese government statistics, foreign firms produce over half of Chinese exports (Morrison, 5). One might think of China as a sort of global production platform, in which intermediate parts from neighboring Asian nations are assembled to make finished products.

In 2003, these intermediate parts amounted to 24% of Chinese imports. In fact, there is a striking correlation between the growth of China's trade deficit with East Asia and the growth of its trade surplus with the U.S.: as China's trade deficit with East Asia roughly tripled between 2000 and 2003 (growing from $39 billion to $130 billion), China's trade surplus with the U.S. also approximately tripled (growing from $90 billion to $250 billion) (Hale, 62). It is not that Chinese corporations have harnessed an unfairly weak yuan to bolster trade, but rather that foreign firms have taken advantage of relatively low wages by outsourcing labor to China, making the nation the final link in many global production chains. In fact, many U.S. corporations have done the same, generating roughly 27% of Chinese exports (Hale, 58). With this in mind, it becomes clear that there is more to China's trade surplus than country of origin labels may suggest.

The Mutual Hostages:

Nobel Prize-winning economist Joseph Stiglitz has characterized the nature of U.S.China economic relations as having "an element of mutual hostage," and with good reason (258). While China's large trade surplus with the U.S. fuels its export-driven economy, Chinese investment in U.S. bonds has made possible the U.S.'s vast deficit spending. Just as China needs the U.S. as a market for its goods, the U.S. needs China as a source of capital inflows.

The U.S. faces a chronically low savings rate, coupled with a high demand for consumption and investment. The U.S. has become dependent upon foreign investment as a source of capital inflows, and China has been its primary investor. Although a substantial increase in the yuan's value would decrease these imports and loans from China, the U.S. would simply have to find another country to borrow from unless it reduced consumption and investment in kind. It is a rule of thumb that a net importer of capital from abroad is also a net importer of goods; foreign investment enables that nation to consume more than it would otherwise (including imports) (Sanford, 2-3). Thus, although the U.S. cries foul when faced with what it perceives as an unfair Chinese trade advantage, U.S. investment and consumption is reliant upon the existence of the very trade deficit many perceive as an economic threat. Any appreciation of the yuan will not create a U.S. trade surplus, but will rather create a trade deficit with a different nation.

For China, the largest benefits to a weak yuan are not in manufacturing, but in agriculture. Although the appreciation of the yuan will only decrease China's bilateral trade surplus slightly, the resulting depression of agriculture prices would be disastrous for China's rural populations. U.S. and E.U. subsidies create downward pressure on global agriculture prices, and although China could subsidize its agriculture in turn, this would be at the expense of diverting money better spent on improvement in other sectors. As the U.S. benefits from Chinese investment made possible by a weak yuan, the rural populations of China rely upon the favorable exchange rate to remain competitive with foreign agriculture (Stiglitz, 259). Despite the increasingly combatitive rhetoric coming from some U.S. politicians and journalists, both the U.S. and China would benefit by maintaining stability in exchange rates.

Impact of the Weak Yuan on U.S. Trade:

That is not, however, to say that exchange rates have no impact on U.S.-Chinese trade. A weak yuan makes Chinese exports less expensive for U.S. consumers, and U.S. exports more expensive for Chinese consumers. In the short-term, this leads to a decrease in U.S. exports. It should be noted, however, that the decline of U.S. manufacturing is larger than exchange rate issues, and is mostly due to changes in production technology and comparative advantage. (Morrison, 3)

Cheaper Chinese exports lead to increased U.S. consumption, as products become less expensive in U.S. markets. However, these increases in aggregate spending are temporary. In the long-term, cheap Chinese exports amount to an overall increase in U.S. purchasing power. And because many U.S. firms buy durable goods and intermediate parts from China, this can cause an increase in U.S. production. (Morrison, 4)

The largest direct impact of a weak yuan is the compositional shift in the U.S. economy it creates. Although export and import-competitive businesses suffer as a result of increased Chinese competitiveness, firms that benefit from the increased capital inflows will fill in these gaps in the economy. There may be a period of somewhat painful adjustment if the sectors that benefit from the capital inflows do not expand quickly enough, but the long-term impact on U.S. employment and unemployment rates as a result of such a shift is null. (Morrison, 4)

Somewhat ironically, the perception of unfair Chinese competitive advantage may influence U.S. trade more than the actual value of the yuan. One must not ignore the political dimension to international trade issues. For a U.S. politician in a district that has suffered a high loss of manufacturing jobs, it may be politically expedient to decry unfair Chinese economic practices as the source of his constituents' unemployment. And in fact, recent years have seen changes in U.S. trade policy toward China as a result of currency manipulation allegations.

On March 30, 2006, the U.S. laid duties on Chinese paper imports in response to claims of unfair Chinese subsidies. This broke with a 20-year policy of regarding China as a non-market economy subject only to antidumping laws (Hale, 59). Much more legislation has been proposed in response to what are seen as unfair Chinese trade practices, specifically Chinese currency manipulation. HR.321 (English) would levy tariffs on Chinese imports and file a WTO case if the Treasury Department detected currency manipulation. HR.1002 (Spratt) would increase tariffs on Chinese goods by 27.5% unless the President indicates that there is no evidence of currency manipulation. HR.782 (Tim Ryan) and S.796 (Bunning) would make exchange rate "misalignment" actionable under U.S. countervailing duty laws, and S.1607 (Baucus) would factor currency "misalignment" - as identified by the Treasury - into anti-dumping cases, would ban federal procurement of products from countries with "misaligned" currencies, and would file a case in the WTO (Morrison, 6). This is just a small sampling of recent proposals aimed at punishing Chinese exporters for what is perceived as unfair competition.

The result of the trade policies suggested by these bills would likely be an increase in consumer prices, assuming that there was no substantial change in demand. It is also likely that China would bring a case against the U.S. to the WTO for violation of trade rules. If successful, it would impose retaliatory duties on U.S. goods (Sanford, 6). These are consequences that U.S. policymakers are presumably willing to face. The bills referenced above are the manifestations of what has become an increasingly protectionist mood in Washington. Increased U.S. dissatisfaction with free trade policies may well prove to be the farthest-reaching impact of Chinese currency fluctuations on U.S. trade in the future.

Conclusions:

Although a weak yuan offers a disadvantage to U.S. export or import-competitive sectors, appreciation of the yuan would not restore a positive balance of trade to the U.S. This is in part due to the low U.S. savings rate and high U.S. demand for investment and consumption, which makes the U.S. dependent on capital inflows from abroad. It is also due in part to the complexities of global production chains, which make the U.S.-Chinese trade imbalance more than a bilateral issue. If Chinese currency fluctuations have a significant impact on U.S. trade, it is in the extent to which allegations of currency manipulation and unfair trading practices have begun to shape U.S. trade policy in regards to China.